Statement Of Paul Smith

Senior Counsel

The American Bankers Association

Actually, our bankers tell us that credit scoring, in fact, gives greater access to mortgage credit rather than creating new barriers for minority mortgage applicants. The use of credit scoring models to better predict whether an applicant might default allows the lender more flexibility in making traditional home loans. During the last 10 years, the banking industry has greatly expanded its efforts to make credit available to less qualified applicants. For example, the housing mortgage secondary-market agencies, Fannie Mae and Freddie Mac, have broadened their underwriting criteria to accept alternatives to the traditional qualifications. Banks have started lower interest-rate or no-fee affordable housing programs, created first-time homebuyer programs in which borrower training replaces some of the missing qualifications of the borrower, and expanded the list of qualifications for potential borrowers.

Many bankers also have said that credit scoring models have been crucial in permitting banks to approve more borrowers' applications than traditional underwriting criteria would have. All of them said that today they make home loans with the use of credit scoring systems that they could not have made or sold to the secondary mortgage market in the past. None of the bankers consulted for this comment reported that they used a credit scoring system exclusively, but rather, as part of the overall mortgage underwriting process. In a home mortgage loan, the property's appraised value, the loan-to-value ratio, the available resources for closing costs and down payment, the applicant's disposable income and other underwriting standards all must be factored into the credit decision. Nonetheless, use of a credit scoring system in the mortgage process is increasing—not only because of the customers' demand for faster underwriting decisions but also because of bankers' interest in expanding credit availability. For example, a higher-than-required credit score might allow the bank to accept a higher loan-to-value ratio than its general lending policy permits. This would permit the applicant to make a lower down payment, and thus, make up for having fewer financial resources than the traditional applicant. This kind of increased flexibility in underwriting by bankers and the secondary market agencies has led to a significant expansion in the access to mortgage credit during the 1990s.

Bank compliance officers also have said that the use of a validated credit scoring system by the bank reduces the subjectivity of the final credit decision and allows compliance officers to better monitor fair lending compliance. One example of that is described in the 1999 settlement between the Department of Justice and Deposit Guaranty Bank at <www.usdoj.gov/crt/housing/ caselist.htm#lending>. Although the bank was said to be using credit scoring, the crux of the case was that lending officers were allowed to freely override the credit score, that is, either granting a loan that should not have been granted according to the score (a low-side override) or not granting a loan that should have been granted according to the score (a high-side override). Thus, the fair lending violations were not in the credit scoring model but in the ignoring of the credit scoring as a factor in the lending decision. The settlement also describes in detail how the successor bank to Deposit Guaranty ensures fair lending compliance through several mechanisms, including using a credit scoring system. Key to that bank's program (and many other banks' programs) is the use of credit scoring to ensure standard treatment of applicants, the limitation of authority to override credit scores, and reviews of any such overrides as well as reviews of many of the denied applications —to determine if the bank has an alternative loan product or program for which the applicant could be qualified.

Besides these and many other steps by banks to ensure fair lending and fair use of credit scores, the bank regulatory agencies have detailed fair lending examination procedures that require bankers and examiners to review credit scoring models for validity and fairness. These examination procedures are available for review by the public at <www.ffiec.gov/fairlend.pdf> with the Appendix on Credit Scoring Analysis at <www.ffiec.gov/fairappx.pdf>. All of these steps and others have been taken to address issues of the fairness of credit scoring and to enlarge the access to mortgage credit for low- and moderate-income individuals. And, we believe that these steps have succeeded.

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